HOW THE JAPANESE LOAN FOR INDIA’S BULLET TRAIN IS A RIP OFF - Bishwajit Bhattacharyya

IF the rupee’s purchasing power has dipped from 19.77 yen in 1985 to 1.72 yen today, then after 50 years can a rupee buy anything more than just a fraction of a yen? Now that the hype over the bullet train has subsided, it is time to do some cold calculations. India will borrow Japanese yen 150,000 crores [equal to Rs 88,000 crores today], bearing 0.1% interest, with a 15 year lock-in period, repayable in 50-60 years. Looks attractive indeed. Prime Minister Narendra Modi is reported to have commented: the loan is “in a way free”. The prime minister was evidently not briefed properly, as the following analysis will indicate.

Today Re 1 buys 1.72 yen, ten years ago Re 1 could buy 2.80 yen and, 32 years ago, say on February 26, 1985, Re 1 could buy 19.77 yen. On February 26, 1985, the exchange rate of dollar/yen was 261 and that of dollar/rupee was 13.20. Divide 261 with 13.20, you get 19.77. So, had India borrowed 150,000 crores yen on February 26, 1985, today, that is after 32 years, the principal amount of loan (without interest) would have swelled 11.49 times (divide 19.77 by 1.72). Depending on repayment schedule and lock-in period of loan, the multiplication factor could have reduced from 11.49 to 6 or 7 on a conservative estimate. This is simple arithmetic and no rocket science.

So, can we not predict what fraction of a yen, Re 1 would buy after 50 years? If the rupee’s purchasing power has dipped from 19.77 yen in 1985 to 1.72 yen today, then after 50 years can a rupee buy anything more than just a fraction of a yen? Unlikely, unless yen interest rate shoots up and rupee rate becomes close to zero, which is highly improbable. Therefore, this 50-year yen loan, with a 15 years lock-in period, is anything but free. It is in fact a rip off. By the time the loan is repaid in 50 years, India would have shelled out Rs 300,000 crores at least, or even more, depending on how quickly the loan is extinguished. This excludes interest of 0.1% on yen loan which would add to the cost. Yen is a dangerous currency and it would be imprudent to ignore its track record.

India can ill-afford to keep such a huge liability in yen unhedged. But even the cost of hedging rupee/yen exchange risk would be prohibitive. Initially India would be required to buy Yen 150,000 crore forward outright in the international market, and keep doing rupee/yen swaps – sell yen spot and buy yen back forward, matching with each due date of loan repayment installment. This process would continue till the entire loan is extinguished. This is called roll-over swap, which corporate in India execute to hedge currency exchange risk in external commercial borrowings. But, such swaps, on each occasion, would entail huge costs for the simple reason that forward delivery of yen against rupee would be at a premium so long as yen interest rate remains lower than rupee.

It is axiomatic that forward delivery of a currency yielding lower rate of interest would always be at a premium vis-à-vis the currency yielding higher rate of interest. The yen interest rate is now close to zero. The rupee repo rate (rate at which banks borrow from the Reserve Bank of India) is 6%. Thus, multiple swaps executed till the currency of the loan would be hugely expensive as forward premia would have to be paid by India on each swap. India would thus end up paying well over Rs 300,000 crores (multiplication factor 3.4 taken) on a most conservative estimate. Notably, rupee/yen quote will not be available directly in the international forex market; consequently, dollar being the intervention currency for India, swaps would have to be performed through dollar/yen quotes. Rupee would thus have be converted into yen only through dollar.

The above figures/calculations do not take into account 0.1% interest burden on yen loan. Today, interest rate in Japan is hovering around zero to fractionally negative, like in Sweden. On September 7, 2017, the Central Bank of Sweden held its benchmark interest rate at (minus) – 0.5%. Similarly, the Central Bank of Japan has slashed interest rate to just shade below zero. Tokyo Inter Bank Offer Rate (TIBOR) is around 0.06%. A ten year Japanese Government Bond yields barely 0.04%. Therefore, 0.1% interest rate that Japan would earn from India is a very lucrative investment opportunity for Japan, which is struggling to fight deflation for over 15 years. More the lock-in period/tenure of yen lending in India, merrier it is for Japan, and costlier it is for India.